Street Capitalist: Event Driven Value Investments

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Street Capitalist: Event Driven Value Investments

Seth Klarman’s Advice for Ordinary Investors

Jeffrey Goldberg of The Atlantic has this great article which asks what the average investor is supposed to do right now. I often discuss investing with everyone I meet, it’s a passion — but I’m often shocked by the preconceptions that people have about it. The ordinary investor has really been misinformed which unfortunately leads to bad decisions and negative returns. Goldberg’s article sets a lot of things straight and would be good reading for anyone you know who is interested in investing but knows little about it. What I liked most about Goldberg’s article was the quotes from Seth Klarman:

Klarman is an acolyte of Ben Graham, the original value investor. Value investors—Warren Buffett is the most famous—seek out distressed, underappreciated assets, buy them, and wait until the rest of the world realizes that they’re worth something.

“The overwhelming majority of people are comfortable with consensus, but successful investors tend to have a contrarian bent,” Klarman said over lunch one day in an empty Boston restaurant. “Successful investors like stocks better when they’re going down. When you go to a department store or a supermarket, you like to buy merchandise on sale, but it doesn’t work that way in the stock market. In the stock market, people panic when stocks are going down, so they like them less when they should like them more. When prices go down, you shouldn’t panic, but it’s hard to control your emotions when you’re overextended, when you see your net worth drop in half and you worry that you won’t have enough money to pay for your kids’ college.”

One theme of Margin of Safety is that people like me aren’t equipped to be investors. “No one knows what he’s doing unless he’s a full-time professional,” he said. “As in many professions, full-time experts have an enormous advantage. Investing is highly sophisticated and nuanced. The average person would have an incredibly hard time competing.”

On the troubles of the small investor:

He agreed with Robert Soros that the financial-services industry treats the small investor not as a client but as a source of ready cash. “The average person can’t really trust anybody. They can’t trust a broker, because the broker is interested in churning commissions. They can’t trust a mutual fund, because the mutual fund is interested in gathering a lot of assets and keeping them. And now it’s even worse because even the most sophisticated people have no idea what’s going on.”

After 15 years of pabulum, I was enjoying, in a perverse sort of way, receiving straight talk from masters of finance.

“Everybody these days is a just-in-time investor. People say, ‘I’m going to leave my money in the market as long as possible, and then pull it out of the market just before I have to write the tuition check.’ But I think we’re seeing that the day you need to pull it out of the market, the market might be down 50 percent. It’s critical not to be greedy. Avoid leverage and don’t invest money that you can’t stand to lose.”

“I haven’t leveraged myself,” I said.

He asked me if I had a mortgage. Yes. He then asked me if the amount of money I had invested in the stock market was greater than the amount I owed on my mortgage—could I liquidate what remained of my portfolio to pay off my mortgage? I could.

“So you are leveraged. Why are you keeping your money in the market?”

“Because—”

“It’s because you think you’re going to make more money in the market than you’re paying in interest on your mortgage.”

“Yup.”

“Well, are you?”

“Uhh, no. But I’m getting the mortgage-interest deduction.”

“Yes, the interest is deductible. But if you had capital gains in the market, you’d pay taxes on those. In the aftermath of this financial crisis, I think everyone needs to look deep within themselves and ask how they want to live their lives. Do they want to live close to the edge, or do they want stability? In my view, people should have a year or two of living expenses in cash if possible, and they shouldn’t use leverage anywhere in their lives.”

“But if I dump my portfolio now, I make my losses real.”

“How are you going to feel if the market drops another 50 percent?”

Klarman brings up an interesting argument. I feel like when people decide they want to invest, they do not properly weigh their actions in the context of their overall financial situation. I have a feeling that many people invest simply to say that they’re invested. As a result, they usually make poor or mediocre decisions. At the very least, they end up investing money in the market when they may have been better suited by paying down debt. The kind of arbitrage practiced, where someone takes out a mortgage but invests in the market is highly risky. But I don’t think many people weigh investing in the market versus their mortgage.

Finally, Klarman’s question to ask anyone who is interested in investing:

“Here’s how to know if you have the makeup to be an investor. How would you handle the following situation? Let’s say you own a Procter & Gamble in your portfolio and the stock price goes down by half. Do you like it better? If it falls in half, do you reinvest dividends? Do you take cash out of savings to buy more? If you have the confidence to do that, then you’re an investor. If you don’t, you’re not an investor, you’re a speculator, and you shouldn’t be in the stock market in the first place.”

Be sure to read the entire article, there are excellent insights from Bill Ackman and Robert Soros among others.

Category: Seth Klarman, Superinvestors, Value Investing

  • http://www.great-option-trading-strategies.com Brad Castro

    I have to disagree with a couple of the ideas presented here.

    First, the idea that you wouldn’t invest in the stock market until your mortgage is completely paid off is as absurd as it’s unrealistic. The current dividend yield on Proctor & Gamble (since that was referenced as an example) isn’t much lower than the current rate on the average 30 year mortgage. And if you’ve held PG for any length of time, your effective yield would undoubtedly be considerably higher than your mortgage rate.

    That’s the power of dividend growth investing in quality businesses – identifying and investing in superior companies that actually pay out a fair portion of the earnings to its investors. If, for example, you’d simply bought and held McDonald’s stock back in 1991-1992, you’d be earning a 25% annual dividend right now. Do you think those long term investors care whether the stock is up 50% or down 50%. Why would they sell and throw away their 25% (and rising) annual dividend.

    Second, I was struck both by the arrogance and the inaccuracy in one of Klarman’s quotes included in your post:

    “No one knows what he’s doing unless he’s a full-time professional,” he said. “As in many professions, full-time experts have an enormous advantage. Investing is highly sophisticated and nuanced. The average person would have an incredibly hard time competing.”

    Right. That’s why the majority of mutual funds UNDERPERFORM the market. Furthermore, it isn’t investing that’s “highly sophisticated and nuanced” – that’s institutional trading and it’s vastly inferior to actual investing as evidenced by my first point.

    On the contrary, the individual willing to put forth a modest amount of effort has considerable advantages over the overtrading, short-term, quarterly performance obsessed, trend chasing, group think, institutional traders responsible for administrating the vast, unruly sums of retirement funds of all the individuals who have abdicated making their own informed investment decisions.

    Why? It’s simple – true investing is actually quite easy. After all, how much research does it take to realize the dominant profitability of companies like Proctor & Gamble, Coke, and McDonalds?

    The rest is just valuation, and there are even some not particularly difficult option strategies the individual investor can employ to help lower his or her cost basis.

    Who knows why there’s such an aversion to investing when the shortcomings of trading are so well documented? Perhaps investing is just too boring. Perhaps the lure of Vegas is just too strong and most people prefer gambling to waiting.

    Anyway, thanks for the post – I enjoyed the reaction it generated in me.

    Best of luck to you -

  • http://www.great-option-trading-strategies.com Brad Castro

    I have to disagree with a couple of the ideas presented here.

    First, the idea that you wouldn’t invest in the stock market until your mortgage is completely paid off is as absurd as it’s unrealistic. The current dividend yield on Proctor & Gamble (since that was referenced as an example) isn’t much lower than the current rate on the average 30 year mortgage. And if you’ve held PG for any length of time, your effective yield would undoubtedly be considerably higher than your mortgage rate.

    That’s the power of dividend growth investing in quality businesses – identifying and investing in superior companies that actually pay out a fair portion of the earnings to its investors. If, for example, you’d simply bought and held McDonald’s stock back in 1991-1992, you’d be earning a 25% annual dividend right now. Do you think those long term investors care whether the stock is up 50% or down 50%. Why would they sell and throw away their 25% (and rising) annual dividend.

    Second, I was struck both by the arrogance and the inaccuracy in one of Klarman’s quotes included in your post:

    “No one knows what he’s doing unless he’s a full-time professional,” he said. “As in many professions, full-time experts have an enormous advantage. Investing is highly sophisticated and nuanced. The average person would have an incredibly hard time competing.”

    Right. That’s why the majority of mutual funds UNDERPERFORM the market. Furthermore, it isn’t investing that’s “highly sophisticated and nuanced” – that’s institutional trading and it’s vastly inferior to actual investing as evidenced by my first point.

    On the contrary, the individual willing to put forth a modest amount of effort has considerable advantages over the overtrading, short-term, quarterly performance obsessed, trend chasing, group think, institutional traders responsible for administrating the vast, unruly sums of retirement funds of all the individuals who have abdicated making their own informed investment decisions.

    Why? It’s simple – true investing is actually quite easy. After all, how much research does it take to realize the dominant profitability of companies like Proctor & Gamble, Coke, and McDonalds?

    The rest is just valuation, and there are even some not particularly difficult option strategies the individual investor can employ to help lower his or her cost basis.

    Who knows why there’s such an aversion to investing when the shortcomings of trading are so well documented? Perhaps investing is just too boring. Perhaps the lure of Vegas is just too strong and most people prefer gambling to waiting.

    Anyway, thanks for the post – I enjoyed the reaction it generated in me.

    Best of luck to you -

  • http://www.StreetCapitalist.com Tariq

    Brad, you bring up a number of interesting points.

    re: dividend investing

    I think your argument here is certainly strong and for people who know what they’re doing it works. But I know quite a few people who purchased shares of companies simply based on the fact that they were around for a long time and offered a good dividend yield. Some of these were in the financial sector and they’ve since blown up or severely cut their dividend yields. People who depended on that income as a means of paying their mortgages may face some difficulties.

    re: Full-time professionals

    I think I had a different take on this point than you. I took it more to mean that most people with full-time jobs do not have the time to sit and learn how to invest so they inevitably are at a disadvantage. Guys like Warren Buffett spend hours a day pouring over 8Ks to get ideas. Even though I go to school, I spend a considerable amount of my free time on investing. I think that a person who’s just setting aside a couple of hours on the weekend probably will not be able to cut it.

  • Tariq

    Brad, you bring up a number of interesting points.

    re: dividend investing

    I think your argument here is certainly strong and for people who know what they’re doing it works. But I know quite a few people who purchased shares of companies simply based on the fact that they were around for a long time and offered a good dividend yield. Some of these were in the financial sector and they’ve since blown up or severely cut their dividend yields. People who depended on that income as a means of paying their mortgages may face some difficulties.

    re: Full-time professionals

    I think I had a different take on this point than you. I took it more to mean that most people with full-time jobs do not have the time to sit and learn how to invest so they inevitably are at a disadvantage. Guys like Warren Buffett spend hours a day pouring over 8Ks to get ideas. Even though I go to school, I spend a considerable amount of my free time on investing. I think that a person who’s just setting aside a couple of hours on the weekend probably will not be able to cut it.

About Me

My name is Tariq Ali, I run Street Capitalist. I recently graduated from the University of Texas at Austin. There, I stumbled onto value investing via the school library. I read everything I could and now I'm here, writing out my thoughts and investment ideas.


I have a lot of heroes when it comes to investing, it seems like every investor has some kind of niche. Some, whose books and writings have had the biggest impact on me are: Warren Buffett, Benjamin Graham, Joel Greenblatt, Seth Klarman, and George Soros.


Have any questions? Want to stay in touch?
Feel free to e-mail me at TariqTX@gmail.com


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